People Power: How to Measure It

6/27/2005

Companies own their capital assets, but (obviously) not their employees. Yet people-powered business is more important every day. In this Harvard Business Review excerpt, two Boston Consulting Group experts outline a way to measure true performance.

by Felix Barber and Rainer Strack

We are hardly the first observers to note the measurement and management challenges posed by the increasingly people-heavy and capital-light nature of business. But in our view, most efforts to take account of this shift focus on the wrong things. For example, attempts have been made to "fix" the balance sheet by including intangible assets. While these attempts certainly have value, they miss a crucial point: The critical resource of most businesses is no longer capitalthat is, assets that a company owns and utilizes at as high a level as possible. Rather, the critical resources are employees whom a company hires and must motivate and retain. The fact that companies don't own their employees, as they do their capital assets, is why methods for valuing "human capital" on balance sheets are so tortuous.

Focusing on intangible assets is troublesome for people businesses in other ways. Whereas the level and nature of traditional capital investment largely determine how productively employees can work, there is huge variation in employee performance at a people businessan investment bank, a hotel, an advertising agencyand the variation is completely independent of assets, tangible or intangible. And while the value employees create in some businesses does take the form of intangible assetsintellectual property, brands, and the likemost employees in people businesses create short-term value directly for customers, month for month and year for year, without the intermediary step of creating an intangible asset.

At a certain point, struggling to make things fit into an existing model no longer makes sense. Liberated from the straitjacket of capital-oriented approaches, a people-intensive business can measure and manage performance by focusing on employees as employees, without having to pretend that they're "capital" or that their value comes entirely from the creation of intangible assets.

People-oriented measurement and management
So if you run a people businessor a company that includes one or more of themhow do you figure out your true performance? And once you know what it is, how do you enhance that performance operationally, reward it appropriately, price it advantageously, and, ultimately, transform it strategically?

The beauty of this approach isthreefold.

Performance Measurement. You start with the right set of performance indicators. The ideal measures will highlight the major drivers of business results, alert you to emerging problems, and provide some hints about their causes. You can get this kind of information by relating performance to people employed rather than to capital employed. Fortunately, doing this is remarkably easy. You simply reinterpret economic profitfor example, EVA [economic value added] or CVA [cash value added]so that it reveals the difference between employee productivity and employee cost rather than the difference between capital productivity and capital cost. In other words, you calculate economic profit using a people rather than a capital denominator.

The logic isn't complicated. You start with sales per employee and subtract supplier costs (including outsourced activities) per employee and capital costs (including depreciation and a capital charge to cover the cost of debt and equity) per employee. The remainder is a measure of employee productivity. Subtract employee costs per employee, and you have economic profit per employee.

The beauty of this approach is threefold. First, unlike many people-oriented metrics, it is grounded in hard financial information gleaned from a company's own accounts rather than in soft assumptions about the impact of human performance on outcomes. Second, it yields realistic returns because the employee denominator of the performance ratio is substantial. Third, it provides meaningful employee-oriented comparisons across a portfolio of operations within a company that aren't skewed by such things as outsourcing or capital investment.

People Management. It goes without saying that managing people is a key task for any company. But in a people business, this task becomes central to success. Because employees represent both the major cost and the major driver of value creation, people-management moves that lead to even small changes in operational performance can have a major impact on returns. Consider a typical security and facilities management company in which operating profit is 10 percent of employee costs and economic profit is 8 percent of employee costs. In such a case, a 5 percent improvement in employee productivity increases operating profit by 50 percent and economic profit by over 60 percent.

Given the high financial stakes, people management needs to be a core operational process and not solely a support function run by the human resources department. Line managers have a vital role to play in improving employee productivity, in terms of both business issues (such as whether to concentrate on large or small accounts) and management issues (such as how to create an organization and a work environment that foster productive output). If success in a capital-intensive business comes primarily from making the right investment decisions, success in a people-intensive business comes from hiring the right people and putting in place processes and an organization that makes them productive.

Managers also need to ensure that employees' interests are aligned with a company's business objectives and their execution. Companies often use surveys and other tools to assess how well they are meeting employees' personal goals. Too often, however, these tools focus only on traditional HR issues, such as work/life balance, benefits, and training. But employee satisfaction and engagement are more likely to be destroyed by conflicts at work than by conflicts between work and "life." A sales manager is charged with selling products from several divisions, but each division gives him a sales target that assumes he will focus on that division's product. Another manager's career depends on a promotion within two years, but she oversees a new service line that will take at least four years to gain traction in the marketplace. The right survey can help spot such conflicts between employee interests and company objectives. Diagnosing and addressing themhowever uncomfortable for the senior line managers who may be the source of the problemis crucial to keeping employees engaged and productive.

Finally, people can't be effectively managed in the absence of relative performance informationinformation that can and will be acted upon. It's astounding how little of this exists at many companies. We've already seen that the major metric, employee productivity, is often calculated using misleading methods. But consider this as well: If employees are, indeed, a company's "greatest asset," you might expect to find some hard information about them in the annual report: How many employees are there? How much do they cost? How productive are they? After all, you'll find detailed answers to equivalent questions about a company's capital assets. The most you'll find in many annual reportsat least in the United States, where only banks are required to report their employee costsis a round estimate of total head count. And even that number is suspect, as Finance and HR often have different methods of defining and counting full-time employees. While more information is available internally, there still are usually big information gaps in areas such as wanted-versus-unwanted attrition, average tenure of employees, and allocation of training funds.

Of course, people businesses need more than people-specific information: For example, customer-related metrics are central to any company and are often needed to measure the productivity of individual employees. But all too often, the problem is not lack of information but the failure to use it. Information generated and reported by a company remains just thatreported. In one company we worked with, the HR department had nearly fifty employee-related metrics at its disposalfor example, unwanted attritionbut only a handful were actually used by line managers in making operations-management decisions.

Excerpted with permission from "The Surprising Economics of a 'People Business,'" Harvard Business Review, Vol. 83, No. 6, June 2005.